Sources want Brazil’s TP regime to align internationally, as some local companies face high interest rates and taxation after continuous rises.
Brazil’s 12th straight rise in interest rates is starting to bite, with transfer pricing consultants saying it could reduce tax deductibility for resident companies that have inter-company transactions with entities abroad.
The Central Bank of Brazil increased the benchmark interest rate to 13.75% on August 3, to combat inflation, before maintaining it on September 16.
“When there is an increase in interest rate by the Central Bank, somehow there is an indirect effect on the application of TP rules by Brazilian companies,” says Ricardo Bolan, tax partner at law firm Lefosse Advogados in São Paulo.
Brazil’s current TP rules for inter-company financing differ from those of countries that align with OECD standards.
Effective in 1997, the TP regime does not follow the arm’s-length principle (ALP). Instead, the rules apply to interest charged to inter-company loans or entities located in jurisdictions with low taxes.
The deductibility ceiling on expenses, or the revenue floor derived from an inter-company loan or other debt instrument, must consider certain benchmark rates.
For transactions in US dollars set at a fixed rate, the benchmark interest rate is based on the current market rate of sovereign bonds issued by the Brazilian government at an international level, indexed in US dollars.
The same rule applies to transactions in Brazilian reals set at a fixed rate but indexed in the currency.
For transactions using other currencies, the benchmark rate is the London Interbank Offered Rate (Libor), in which all dollar Libor tenors are set to cease after June 30 2023.
While these rules determine the deductibility of the interest on related party loans, the spread determined by the Ministry of Finance must also be considered, according to Igor Scarano, TP director at consulting firm Kroll in São Paulo.
“When the Brazilian entity is the borrower, the deductibility ceiling of the expenses should take into consideration the proper interest rate plus a spread of 3.5%,” he explains.
“When the Brazilian entity is the lender, the floor revenue should take into consideration the proper interest rate plus a spread of 2.5%,” he adds.
As TP rules in Brazil differ significantly to OECD standards, Brazil-resident companies will be exposed differently to base rate rises than corporations in OECD member countries.
Victor Kampel, tax partner at law firm Campos Mello Advogados in São Paulo, says the effect of the interest rate rise on inter-company financing is particularly relevant today given that carrying out a loan has become expensive in Brazil.
Ups and downs
As interest rates fluctuate, the yields will also vary. A 13.75% base rate would mean the price of bonds falls and yields rises – and vice versa. In short, if Brazilian companies are borrowing money from non-Brazilian related parties, they may be required to pay higher interest in these transactions.
“Whenever the interest rate in Brazil rises, the interest related to the government bonds also rises,” explains Scarano. “This is how it affects the TP environment.”
As Brazil is not aligned with OECD guidelines, the TP criteria for certain types of inter-company loans, such as the six-months Libor with post-fixed interest rate, might not rise accordingly.
In this case, Brazilian companies would not be able to fully deduct interest.
Allan Fallet, partner at law firm Mauger Muniz Advogados in São Paulo, explains how corporations with inter-company transactions will be affected by the increased rate.
“If the domestic market has a high rate today while the market rate of Brazilian sovereign bonds issued in the foreign market for the same term is lower, the Brazilian-resident company that performed the operation through an intra-group transaction with an associated company abroad could only deduct interest expenses up to a lower limit,” he explains.
“A Brazilian-resident company without any connection abroad will be able to fully deduct the interest percentage practised in Brazil,” he adds.
Corporations with inter-company operations and with a foreign connection will be subject to higher taxation, according to Fallet.
The added fixed spread defined by the finance minister, which is often at a low value and far from the market interest rates in Brazil and the ALP, means that taxpayers could face a significant loss in deductibility.
The aim would be to have a loan established in a certain way to allow the Brazilian company to deduct as much interest as possible, according to Bolan.
Scarano says multinationals that intend to lend to or borrow from a Brazilian subsidiary using a fixed rate in US dollars or Brazilian reals should also check the applicable government bond yield to avoid complications, as the Central Bank’s decisions affect these rates.
Dante Zanotti, partner at law firm Lefosse Advogados in São Paulo, says that the limits for deductibility could rise if the applicable criterion is the remuneration of Brazil’s sovereign bonds in US dollars or Brazilian reals.
“On the other hand, for inter-company cross-border loans denominated in Brazilian reals or US dollars with pre-fixed interest rates, Brazilian companies may actually have more space to fully deduct interest expenses for corporate income tax purposes,” says Zanotti.
While the base rate rises have consequences for the prices of bonds, taxpayers must also take into consideration the exchange rate. If bonds or transactions are in Brazilian reals, they will have a higher rate than bonds issued in US dollars, which could affect bond rate calculations.
As Bolan notes, “Our exchange rate has historically changed a lot. There have been huge variations.
“In the past year, the Brazilian real has devaluated a lot compared to other currencies. Higher interest rates on bonds will make them more attractive to investors.”
Out of whack
The effect of higher interest rates on inter-company financing shows once again that Brazil’s non- alignment with OECD standards makes it nearly impossible for tax consultants to include economic context within a company’s TP analysis.
By failing to provide a mechanism that equates the parameter price of interest to market conditions, and not aligning with OECD rules, the TP regime ends up violating several Brazilian constitutional tax principles, according to Fallet.
This could lead to a lawsuit from taxpayers who identify a loss according to the use of these margins, he adds.
Hanna Lauar, tax consulting manager at law firm Azevedo Sette Advogados in Belo Horizonte, says that there is no economic rationale, which makes things unclear for the taxpayer.
“If Brazil followed OECD rules, the economic purpose of any transaction including loans would fit better – the arm’s length would fit better the economic purpose of transactions. Here we can’t follow the economic rationale,” she says.
“We just have a law and we have to follow that law. It would be better from a non-aggressive tax planning [perspective] and for the taxpayer to consider an interest rate usually considered for a loan,” adds Lauar.
In April this year, Brazil announced it intended to implement Chapter X of the OECD TP guidelines on inter-company financial transactions. The new framework could tackle the risk of double taxation and double non-taxation, as well as attract foreign investment in Brazil.
Until then, taxpayers will continue to bear the consequences of higher interest rates as inter-company transactions do not align with the ALP.
Fonte: ITR